'What is liquidity' is a question which is commonly asked, if you Google it, hundreds of pages come up, and if you Google a definition the suggestive search is there, ready and willing to finish your sentence for you. Economists and stock traders know exactly what the word means, but for everyone else, it's hard to find a clear meaning.
Stock-n-options.com, an educational site that instructs all levels of traders, defines liquidity as “A measure of how quickly a stock or option can be sold at a fair price.” The site goes on to say, “The Daily Volume and the open interest are two good ways to measure option liquidity.” That might mean something to someone who is in the market, but what about people who are just listening to the financial news and hear the word thrown around by analysts?
Advfn.com, a site which provides free information about stock prices, quotes and charts, gives a slightly different explanation. “A high level of trading activity,” the definition starts. “Allowing buying and selling with minimum price disturbance. Also, a market characterized by the ability to buy and sell with relative ease.” However, economists, without exception, talk about liquidity as if it’s a good thing, and companies don’t necessarily want ‘minimum price disturbance,’ in their stock, they want their stock price to rise.
Advfn.com then goes on to say that liquidity is the antithesis of illiquidity, which, if you don’t know what liquidity means in the first place, is less than helpful.
An Explanation for the Non-Experts
These explanations are more suited for people who understand the stock market. For the uninitiated, there are other definitions in Laymen’s terms. The question has been frequently asked on Yahoo! Answers, and the most useful answer, as voted by Yahoo users, comes from “A Beginner’s Guide to the Balance Sheet,” a paper written by two professors and a University of Florida extension.
“Liquidity is the ability of a firm to meet debts when they become due,” the definition states. In other words, the ability of a company to pay their bills. So by that definition, when you hear an economist use a phrase like, “They want to try to inject liquidity into the market,” what they’re saying is, they want to help companies continue to operate.
The trouble is, this definition clashes with the previous two. how quickly and easily a company’s stock is trading doesn’t necessarily mean they are in good financial health, as we saw in the early part of the 21st Century, and during the dotcom boom, when companies actually reported loses and still saw their stock sky-rocket.
It’s a word that’s as old as the stock market itself, and it’s been used to many times in so many different contexts, that finding two economists that agree on a definition is like finding two snowflakes that have exactly the same pattern. An economist once told a journalist who asked him for a definition that, “Liquidity means liquidity.” But if you ask 20 different experts, you will most likely get 20 different explanations. It’s sad to say, but this definition is probably the most accurate one you’re going to find.
Patrick Cooley - My name is Patrick Cooley, and I am currently living in Dayton, Ohio, working as a freelance writer for anyone who needs my skills. ...
